CLOS ARE PERSISTENTLY IN THE FINANCIAL HEADLINES, and most of the over-the-top articles would have you believe they are the next crisis waiting to happen. While such fearmongering may make for a good news story, we do not believe it presents a fair or accurate assessment of the actual risks that CLO investments pose — or the benefits they may offer many investors. Here we aim to debunk four common CLO-related myths that have been perpetuated by the press.

Myth #1: All CLOs are levered investments.

Facts:

• CLOs do not contain leverage or any type of borrowing. Rather, a CLO issues debt to finance the purchase of a portfolio of broadly syndicated bank loans that is actively managed by a bank loan manager. If US$500 million of debt is raised, for example, US$500 million of bank loans is purchased (less fees).
  
• CLO equity is a levered investment (~11x) in the underlying broadly syndicated bank loan pool, as is the BB tranche (~8x levered). CLO mezzanine and equity investors buy the most junior tranches of the CLO, thereby structurally subordinating themselves and creating a levered investment in the underlying bank loan pool. There is no borrowing involved; there are no more dollars invested in bank loans than were raised by the issuance of debt to institutional investors…

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